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Valuation of Bonds and Common Stocks

Valuation of Bonds and Common Stocks. Bond Valuation Stock Valuation How Common Stocks are Traded Estimating the Cost of Equity Capital Linking Stock Price and Earnings per Share. How Common Stocks are Traded. Primary market New capital Initial Public Offering (IPO) Secondary market

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Valuation of Bonds and Common Stocks

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  1. Valuation of Bonds and Common Stocks • Bond Valuation • Stock Valuation • How Common Stocks are Traded • Estimating the Cost of Equity Capital • Linking Stock Price and Earnings per Share

  2. How Common Stocks are Traded • Primary market • New capital • Initial Public Offering (IPO) • Secondary market • Auction market • Specialists as market maker (NYSE) • Computer based (Tokyo) • Dealer market • Over-the-counter (OTC) • Nasdaq

  3. Common Stock Price Information • Wall Street Journal • Redesigned tables – largest 1500 stocks • Stock name • Symbol • Close • Net Change (daily) • Symbol for 52 week high or low • Online • finance.yahoo.com • Quote.com • www.nasdaq.com • moneycentral.msn.com./investor

  4. Estimating the Cost of Equity Capital • Let r = the cost of equity capital • Rearrange the perpetuity with a constant growth rate formula:

  5. Example – Cost of Equity Capital for GE where 1.12 is the forward annual dividend rate (Yahoo! Finance) 36.19 is the current price 10% is the next 5 year growth estimate (Yahoo! Finance)

  6. Alternative Estimate of Growth g = Plowback ratio x ROE GE’s plowback ratio = 50% (Yahoo! Finance) GE’s ROE = 18.65% (Yahoo! Finance) g = .5 x .1865 = .093 r = .031 + .093 = 12.4% Warning: Constant growth rates are not valid. In practice, need to vary growth rates.

  7. Linking Stock Price and EPS Present value of growth opportunities (PVGO)

  8. Example – Estimating PVGO for GE • Average earnings under a no growth policy, estimated as average of 2007 and 2007 (Est.) • 2006 = 1.99, 2007 = 2.22, Average = 2.105 • PVGO as a % of stock price = 55.6%

  9. Next Class • Using Net Present Value to Make Investment Decisions • Student presentations • Net Present Value • Internal Rate of Return • Read Chapters 5 and 6 in the text

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